Lecture 11 & 12 Ratio Analysis

7/27/2019 Lecture 11 & 12 Ratio Analysis

1/16

RATIO ANALYSIS

Purpose is to analyse a set of accounts via:

Profitability

How much profit thecompany has made

Liquidity

How much cash is available


2/16

PROFITABILITY

Return On Capital Employed How much

profit is generated from the capital invested. The

higher the better.

Gross / Net Profit margin How much profit is

generated from the sales. The higher the better

Asset Turnover How much sales are

generated from the capital invested.


3/16

LIQUIDITY

Current Ratio Current assets compared with

current liabilities. Should be about 3:1.

Acid (Quick) test

Current assets less stockcompared with current liabilities. Should be

about 1:1

Stock Turnover How fast our stock is sold.

The quicker the better


4/16

LIQUIDITY

Debtors days How long it takes for our

customers to pay. The shorter the better

Creditor days How long it takes for the

firm to pay their suppliers. The longer the

better as long as credit agreements are

not breached.


5/16

Current ratio =Current assets

Current liabilities

= 30,500

24,000= 1.27

Acid test =Current assets - Stock

Current liabilities

= 30,500 14,000

24,000= 0.69

Stock turnover =Stock * 365

Cost of sales

= 14,000 * 365

42,000= 122 days

Debtor days =Debtors * 365

Sales

= 16,000 * 365

60,000= 97 days


6/16

Creditor days =Creditors * 365

Cost of sales

= 24,000 * 365

42,000= 209 days

Gross profit =

margin

Gross Profit * 100

Sales

= 18,000 * 100

60,000= 30%

Net profit =

margin

PBIT * 100

Sales

= 2,500 * 100

60,000= 4.2%

ROCE =Profit * 100

Capital + Long term loans

= 2,500 * 100

19,000= 13%


7/16

PROFITABILITY

2001 2002

Gross Profit Margin 69% 63%

Net Profit Margin 20% 24%

ROCE 21% 24%


8/16

COMMENTS

Sales have increased by 24%.

Gross profit margin has fallen by 6%. Could be

lower prices or higher costs.

Net profit margin has increased by 4%, reflectingreduced overhead expenses.

ROCE rose from 21% to 24%, shows a healthyreturn.


9/16

LIQUIDITY

2001 2002

Current Ratio 1.4 : 1 1.67 : 1Liquid Ratio 1.25 : 1 1.42 : 1

Debtor days 49 days 41 days

Creditor days 51 days 46 daysStock days 18 days 17 days


10/16

COMMENTS

Current and liquid ratio have increased. This is due to ahigher stock level and lower bank overdraft. The liquidityposition seems to be a strong one.

Debtor days have fallen, improving the cash flow of thecompany.

Creditor days have fallen and are lower than the debtor

days. This also improves the cash position of thecompany.

The company is in a strong financial position.


11/16

ROCE = 66 / 300 * 100 = 22%

Operating profit margin = 66 / 820 * 100 = 8%

Assets turnover = 820 / 300 = 2.7 times a year

Working capital period = 70 / 754 * 365 = 34 days

Room Occupancy = 5900 / (18 * 365) = 90%

Turnover per employee = 820,000 / 20 = 41,000

WORKINGS

Note:Working Capital = Net Current Assets


12/16

APPENDIX

Stately HomesPLC

HomelyLtd.

Target Actual

ROCE 26% 22%

Operating Profit Margin 13% 8%

Asset Turnover 2 times 2.7 times

Working Capital period 20 days 34 days

Room Occupancy 85% 90%

Turnover per employee 30,000 41,000


13/16

REPORT WRITING

Header : - To:

From:

Date:

Subject:

Introduction Purpose of the report (Why ?)

Body of report Comment on the ratios

Link ratios to give more meaning

Conclusion Overall strengths and weaknesses


14/16

MEMORANDUM

To: Management Accountant, Stately Homes PLC

From: Assistant

Date: XX March 2007

Subject: Appraisal of Homely Ltd.

Introduction Carried out appraisal of Homely Ltd. using

key accounting ratios and comparing them with the

targets.


15/16

ROCE Homley Ltd. figure of 22% is below the target of 26%.

Management action would be needed to improve profit margins or

increase asset turnover.

Operating profit margin of 8% is well below the target of 13%.

Therefore, cost cuts are needed or room rates increased.

Asset turnover of Homely Ltd. Is above that of the target. Hence,

sales are good even if profits are poor.

Working Capital Period of 34 days is almost double the target. In

other words, it is taking too long to for debtors to pay. There will need

to be a better control over debtors, and a reduction in stock levels.

Percentage room occupancy is 5% above the target. This may be

due to lower room rates

Turnover per employee is healthy mainly due to the low room rate.


16/16

CONCLUSION:

Homely Ltd. appears to have both strengths linked with

turnover, and weaknesses associated with costs and

working capital. Management action should concentrate

on exploiting the strengths, whilst improving the

weaknesses.

Documents

Lecture 11 & 12 Ratio Analysis